Saturday, January 22, 2011

Is a newly minted coin money?

In comments, someone asked if a newly minted coin was a financial asset or not.

Here is my response -- it is not a financial asset, it is a real asset. A financial asset is an asset that has a corresponding non-equity liability. A real asset has no corresponding non-equity liability, and therefore get some nominal value associated with it and booked as equity. The details of how the nominal value get assigned can be important, but not in the context of this discussion (financial vs real assets).

A newly minted coin has no liability associated with it, and is therefore not a financial asset. If the coin belongs to the Mint that produced it, then it's nominal value would be booked as equity to that Government entity. The difference between its production cost and its nominal value would be true seignorage.

If the coin left the Mint and went into general circulation, it may not be counted as Government spending depending on how exactly the transfer happened. When the coin was deposited at a bank, then it would enter (for the first time) the reserve system as it would be booked as a deposit in the creditors account (credit bank liability), which would credit the banks reserve account (asset), which in turn would credit the reserve account (liability) held at the Fed, which would debit its (negative) equity entry. At this point, the coin has become a financial asset.

The Mint’s inventory of coins is held at the cost of production. There is no equity mark up at that point.

Coins sold by the Mint result in profit and equity mark up for the Mint.

Coins are not treated as a balance sheet liability from an accounting perspective. Coin is not recorded as a liability on any state balance sheet – Mint, Fed, or Treasury. This is an accounting choice. It is treated only implicitly as an off-balance sheet contingent liability of the state.

Coins are a (contingent) liability in a number of senses – the obligation to redeem due to damage or surplus requirements, as well as the Chartalist notion of liability to redeem for payment of tax liabilities.

By contrast, notes are treated as a Federal Reserve balance sheet liability from an accounting perspective.

However, there is no economic difference in the nature of the liability as between notes and coin. Both are effectively contingent liabilities in the above sense. One is recorded on balance sheet; the other is not.

As noted, coins are sold by the Mint at nominal value. Hence their seigniorage value is captured in the income statement of the Mint. Profit is either retained for investment or remitted to Treasury.

Conversely, notes are sold to the Fed at cost. Therefore, their seigniorage value is captured in the financial statements of the Fed. This is done through both the balance sheet and the income statement.

Notes are issued by the Fed as a funding instrument, collateralized by Treasuries. From a balance sheet accounting perspective, the exchange of notes for bank reserves is not technically a sale of notes by the Fed – it is the issuance of a funding instrument, settled in reserves.

Note seigniorage is earned by the Fed at the income statement level according to the interest margin between earning assets (usually Treasuries) and zero cost liabilities (notes).

The difference in accounting treatment between coins and notes reflects several factors:

a) The nominal amount involved is much lower for coins, so balance sheet representation is a less material concern

b) The relative amount of fixed investment required for production is much higher for coins, which means less seigniorage is left for financial asset accumulation

In theory (very much), it would be possible for the Fed to record the issuance of notes to the banks as a sale rather than balance sheet funding. If that were done, what are currently the note liabilities of the Fed would appear instead as retained earnings, and the liability associated with the notes would be off balance sheet, as it effectively is now for coins. This alternative version Fed equity capitalization would correspond to the book value of the present value of the seigniorage that is earned at the income statement level by the interest margin between earning assets (usually Treasuries) and zero cost liabilities (notes).

The classification of real versus financial is largely semantic, given the use of physical coins as a medium of exchange. I’d say technically coin is (always) a real asset, used as a medium of exchange. The accounting on the books of the Mint is at cost; at nominal once it leaves the Mint.

None of this contradicts the idea that both notes and coins are liabilities in the Chartalist sense.

"Treasury currency outstanding: Coin and paper currency (excluding Federal Reserve notes) held by the public, financial institutions, Reserve Banks, and the Treasury are liabilities of the U.S. Treasury. This item consists primarily of coin, but includes about a small amount of U.S. notes--that is, liabilities of the U.S. Treasury--that have been outstanding since the late 1970s. U.S. notes are no longer issued."

Z1 takes occasional liberties in macro balance sheet classification in order to provide a coherent stock/flow consistent interpretation of the flow of funds. I'm sure you're familiar with examples of this. As another example, this would be consistent with classifying what I've termed a contingent liability as a "normal" liability for flow of funds presentation purposes.

In fact I don't believe coins are recorded as a liability on the official financial statements of the US government. I'm investigating this, and haven't found them there so far.

My first impression re Swiss without looking at the document is that it seems like standard inventory accounting (at cost), and standard with respect to bank notes also, in that CBs buy bank notes at their production cost/price, and then earn seigniorage on them once they are issued.

unless someone else has noted this trivial point, i would just say a newly minted coin is probably just to replace an old mangled coin. this probably isn't the theoretical answer the question was looking for.